April 28, 2014

Who Is Getting Whacked by the Latest Sanctions on Russia—and Who Isn't

On Monday morning, President Obama, speaking from Manila, announced a new round of sanctions against Russia, designed to punish the Kremlin for blowing up the Geneva agreement. On the list are “seven government officials, including two key members of the Russian leadership’s inner circle, and 17 entities,” including little boutique banks owned by Putin’s buddies who were hit by the first round of sanctions.

Here’s what it all means.

Who’s not on the list?

Administration officials are flaunting the fact that they had the gumption to sanction Sergei Chemezov, the arms trade overlord and close Putin ally, and Igor “Darth Vader” Sechin (also known as “the scariest man on earth” and head of state oil company RosNeft). These two are some of scariest, most powerful dudes Putin has working for him.

But equally telling are the names not on Monday’s list: Alexei Miller, head of Russian state gas giant Gazprom. There’s a rumor going around that Miller was on the list but was taken off to appease the jittery Europeans, who still rely on Gazprom for much of their gas. According to American officials, there was no draft and no erasure, but not including Miller on the list this go-around was indeed a concession to a reluctant and Russia-dependent Europe, which the Obama administration has been hauling along with a tremendous amount of patience. “Europeans have come a long way, especially given where they started,” says one administration official involved in the sanctions deliberations.

RosNeft. Sechin’s sanctioning is a big deal and the White House banning him from traveling to the U.S. is a big deal. Since 2011, Sechin has been traveling to the U.S.—somewhere this former Soviet spook had never been—rather frequently: that year, Rosneft and ExxonMobil inked a deal that swapped Exxon’s new exploration rights in the Russian Arctic for RosNeft’s right to explore in the Gulf of Mexico. While sanctioning Sechin is not enough to freeze this deal—apparently, Exxon has been quite nervous about losing access to the resource-rich Arctic—this is certainly flirting with it.

Russian state media companies, the ones responsible for the relentless propaganda campaign, including the broadcast in which one Russian propagandist threatened to turn the U.S. into “radioactive ash.” This is especially clear in looking at the balance of who from Putin’s inner circle bears the brunt of the sanctions: the Rotenberg brothers and Gennady Timchenko, but not Yuri Kovalchuk, who was on the first list of sanctions. Kovalchuk is a key figure not just because he’s in Putin’s inner circle, but because Putin also trusts him to own—and thereby control—key media assets.

This was by design. According to several current and former government officials, the White House has consciously avoided going after the Russian media—unlike the Europeans, who, last month, sanctioned telejournalist Dmitry Kiselev, he of the radioactive cloud—in part out of principle, in part out of fear of the optics of the world’s most lecture-y democracy attacking even a sham press. “There’s been a little bit of reluctance to go after the media at least for now, though that could be revisited,” says the administration official. (The others weren’t willing to be quoted.) “It isn’t really media, it’s more a propaganda apparatus, and we might go after that later. But we wanted to start somewhere else.”

That said, the White House did sanction Aleksei Pushkov, a rabidly anti-American television personality. Their cover? He’s the head of the Russian parliament’s foreign affairs committee.

Who is on the list?

Non-people. This is important, as sanctioning whole businesses affects a whole layer of implicit, complicit individuals. This is something unique to U.S. policy. Watch to see who is on the European list announced today, for example. It will be just individuals, not entities. Why? European sanctions norms call for targeting specific individuals demonstrably tied up with X act of aggression, rather than entities.

The boutique banks—or “crony banks,” as U.S. officials are calling them in private—are not a crucial part of the Russian economy, but they matter for other reasons. SMP Bank, for instance, is ranked 36th among Russian banks, in terms of the size of its assets, as determined by the Russian Central Bank. InvestCapitalBank is 90th. But both banks are owned by the Rotenberg brothers, Putin’s childhood friends and judo buddies. They are not retail banks that have civilian clients and give out car loans; rather, they service the Rotenberg’s various projects, like building pipelines for Gazprom. And the Rotenberg company responsible for that (StroyGazMontazh, or SGM) was sanctioned, too.

This approach is more comprehensive than simply saying the Rotenbergs can’t visit New York; instead, it seeks to paralyze several arms of their financial empire, which both enables Putin’s rule, and directly, existentially benefits from it. And, so far, it affects them without inflicting the civilian casualties that would result from sanctioning a major Russian retail bank, like Sberbank.

What’s the point?

The psychological factor of naming these banks is not to be underestimated. First of all, it removes the curtain cloaking this shadowy “crony economy,” full of small, strange banks whose business is far from obvious. It shows the Russians that we know how and by whose hands the economy runs. Furthermore, says prominent Russian economist Sergei Guriev, “the continuation of adding companies and banks indicates that future sanctions may include certain truly systemic financial institutions.”

For instance, in the tense lead-up to Monday’s announcement, GazpromBank and VEB (a massive bank close to Putin that is responsible for financing much of the Sochi Olympics) were rumored to be on the sanctions list, which depressed the Russian market. Stocks immediately rebounded when investors learned they were not (yet) being targeted. This kind of volatility—especially when coupled with the ratings downgrade—serves to further undermine Russia’s economy.

The radioactive factor is also an important one. StroyGazMontazh may not have any U.S. business and Arkady Rotenberg may have no U.S. assets—an unlikely proposition, but let’s go with the hypothetical—but given U.S. dominance of the world financial system, the Rotenbergs’ days of smooth sailing may just be over. “I don’t think the Russians quite understand the extent to which the world financial system is integrated with the dollar and the U.S. financial system,” says one administration official involved in the sanctions deliberations. “I don’t know if these people have assets in the U.S. I always suspected most of their assets are in Europe. But once the U.S. banking system has redlined you, it’s hard to do business. You’re radioactive.”

Which is why it’s starting to work. Western financing in Russia has seized up. According to an investor note sent out by the political risk management firm Eurasia Group,

U.S. and EU actions to date have hurt Russia's economy. Capital outflows are soaring, contributing to S&P's 25 April downgrading of Russia's foreign currency sovereign rating. The Russian market is off roughly 10% since the takeover of Crimea. Foreign banks have become more skittish about lending to Russian firms.

Here are the U.S. government estimates of the pain:

This is [sic] contributed to sharp declines in the value of Russian equities, which are down almost 15 percent this year, and the Russian ruble, which has depreciated almost 9 percent against the dollar since January 1st.

The Russian stock market is performing worst among major emerging market economies this year. And the ruble is also the worst performing currency among major emerging markets over the same period.

Our sanctions and the overall increase in uncertainty in the Russian economy have led investors to demand significantly higher risk premiums to hold Russian government debt, causing the country’s 10-year bond yields to increase nearly 175 basis points since the start of the year. That is worse performance than high-risk borrowers such as Greece and Portugal. Russia’s 10-year bond is now trading at about 9.7 percent, and things are so bad that the Russian government was forced to cancel a recent bond auction because of a lack of investor demand.

None of which is to say it’s changing Putin’s calculus. In fact, I’d argue that the more we press on him, the more he’ll dig in. That’s just his style. But at least it’s some form of punishment, which is more than the Bush administration did when Putin invaded Georgia.

This article has been corrected to reflect the fact that GazpromBank and VEB are not publicly traded. We regret the error.